This post is a comprehensive update as to the cost of new and existing homes vs. renting, all measured compared with median household income. As such it is epistolary in length. So here is the TL:DR version:

as a multiple of median household income, new home prices are at an extreme beyond even the peak of the housing bubble, while existing home prices are about 5% under theirs

but unlike then, when apartment vacancies were high and rents cheap, now rents are *also* at an extreme as compared with median household income

even with their recent increase, interest rates are still lower now than during the housing bubble, so the median monthly mortgage payment adjusted for median household income is even still about 10% less than it was at the peak of the housing bubble

if the trends of rising prices and interest rates continue, at some point they will overcome the demographic tailwind of the large Millennial generation having reached typical home-buying age. At that point there may be another deflationary bust
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Half a year ago I wrote a long post discussing “the real cost of shelter,” by which I meant not just the downpayment on a house, but the monthly carrying cost for a mortgage, and comparing both of those with median rent.

That comparison showed that, while the “real” cost of a house downpayment was at a new high, the “real” cost of median asking rent was even higher. By contrast, the monthly carrying cost of a mortgage was quite moderate. This meant that, if a buyer could find a way to put together a downpayment, home-owning was a bargain compared to renting.

As I’ll show below, six months of price and interest rate increases later, there is even more stress on both homebuyers and renters.

By way of a quick recap, I wrote six months ago that I had never seen a discussion of the relationship between the relative cost of homeownership vs. renting, particularly as a function of the household budget. The choice (or ability) to live in the residence one desires isn’t a matter of its cost by itself, but also the relative cost of the type of residence. What is the cost of a house compared with the cost of an apartment? How expensive are each of them compared with a household’s income? If both are too expensive, maybe the choice is made to live with mom and dad as an extended family.

So, here are the three relationships I’ll look at again in this post

1. the “real cost” of a downpayment on a house.
2. the “real cost of renting
3. the “real monthly carrying cost” of a mortgage

The best metric for calculating these “real” costs on a household is median household income

1. The “real cost” of a downpayment on a house

In order to generate the “real cost” of buying a house, the best way is to compare the median household income with the median house price.

One drawback is that the Census Bureau only publishes median household income annually in September — so there is as much as a 21 month lag. Here’s what the most recent data — through 2016! — looks like:

Figure 1

The good news is that Sentier Research published monthly estimates based on the Household Survey into 2017. The bad news is that they discontinued this service a year ago.

The renewed good news is that the website Political Calculations has picked up the mantle and continued to estimate the monthly change in median household income. Here’s what that looks like as of their most recent update through February:

Figure 2

After I engaged in some correspondence with them, last week they updated their metric on “real” house prices making use of their monthly median household income estimates (NOTE: here nominal values are used for both median income and median prices):

Figure3

While they use new home sales for their median house prices, we get the same result if we use the FHFA house price index:

Figure 4

Meanwhile, the median price for an existing home, which peaked at $230,000 in summer 2005, has continued to appreciate at nearly 6% a year this year:

Figure 5

If that pace continues, by this summer the median price will be about $280,000, 22% above the bubble peak. Since nominal median household income has increased about 25% over that same period of time, they will be only aabout $7500, or about 3% below their “real” bubble peak.

In short, no matter how you measure, in real terms house prices are at or near their most expensive ever, even including the peak of the housing bubble.

So, why haven’t home sales rolled over? Part of the reason is the demographic tailwind I discussed last week. Because Millennials of peak first-home-buying age now number about 15% more than the Gen Xers of 2005, a build-up that has grown year after year for the last decade, it presumably takes even more financial stress to overcome that tailwind.

But there are two other reasons why home sales haven’t turned negative yet: the relative (un)attactiveness of renting, and the monthly carrying cost of mortgage payments. Let’s look at each of them in turn.

2. The “real cost” of renting

Here is the median asking monthly rent for an apartment in the US since 1995 (note: the series goes back to 1988):

Figure 6

In 1988 the median rent averged $343 per month. In the first quarter of this year it was $954.

Now, here is what it looks like in comparison with median household income:

Figure 7

If house prices have risen to new highs several times since the turn of the Millennium, so have apartment rents — almost relentlessly.

In percentage terms, in 1988, the median rent for an apartment was 14.5% of median household income. That rose to slightly over 16% in the mid 1990s before falling to the series’ low of 13.7% in 2000. It had risen to a record 18.4% of median household income in the 2nd quarter of 2017, the last available data when I first published this piece.

Since then, the situation has only gotten worse. In Q3 median asking rent was 18.7% of median household income. In Q4 it was 18.6%. And in the first quarter of 2018 it rose to 19.3%!

Note, by the way, that even if we make use of the metric of “rent of primary residence” from the monthly CPI report, which I think has been underestimating rent increases (because both Zumper and Rent Cafe, two private measures, are much more in accord with the surge in “median asking rent”), we see that rent increases have outpaced median household income, which over the same period of time has risen about 220% nominally:

Figure 8

So one very big difference between the present situation and that at the peak of the housing bubble is that renting was a *much* more attractive option 12 years ago than it is at present.

3. The “real monthly carrying cost” of a mortgage

A second big difference between the present and the housing bubble is that mortgage interest rates generally ranged between 5.5% and 7% then, but quickly fell below 5% in this expansion, all the way to a low of 3.3% in 2013:

Figure 9

Recently they have risen significantly.

With that in mind, let’s take a look at the monthly cost of living in a house. The below graph shows the median monthly mortgage payment for a house (blue) compared with median household income (red). Median monthly mortgage payment is calculated by using the median house price and the 30 year mortgage rate for each quarter, and consulting an amortization table using those values. This is done by showing the percentage of median monthly income (1/12 of the annual) that one month’s mortgage payment consituted (note: I am assuming a 10% down payment, with 90% mortgaged to be consistent. Using a different down payment does not change the shape of the comparison at all, only the nominal values):Figure 10

Last year, when I first posted this metric, the monthly payment for the median house wasn’t extreme at all, but rather very moderate in terms of the long term range.

Going back to 1988, the median mortgage payment was slightly over 40% of median monthly household income.

This fell back under 28% at the end of 1998 before rising to 32% in 2000.

After falling briefly, at the peak of the housing bubble in 2005 it had risen to 31.4%, and actually reached a secondary peak in Q2 of 2006 of just over 35% of median monthly income.

At the bottom of the bust at the end of 2011 it made a new low of 23%.

As of Q2 of last year, the median monthly mortgage payment was still less than 24% of median household income.

BUT, with the increase in both house prices of over 5% YoY, and the increase in mortgage interest rates to 4.28% as of Q1 2018, that has now risen to 29.5%

Mortgage payments for new buyers in 2018 and not nearly so moderate as they had been earlier in this expansion. But they are not yet at the extremes they were in 2005 and 2006.

The overall trend in the last 30 years has been that monthly mortgage payments have fallen from over 3 times median rent to about 1.5 time median rent now. Put another way, even at the peak of the housing bubble, the monthly carrying cost of a house was about 2.3 times the median cost of renting an apartment. At the bottom of the bust, that fell to 1.4 times the cost to rent. For the last five years, monthly mortgage payments have hovered near 1.5 times the median asking rent.

What is particularly noteworthy is that *even with* the recent big increase in mortgage payments, rents have also increased so much so that the 1.5 ratio still holds.

CONCLUDING REMARKS

By comparing the “real” cost of housing to renting, both in terms of down payments and monthly mortgage payments, we can make sense of some of the biggest trends in the market for shelter.

Record down payments are keeping an increasing number of prospective buyers, especially first time buyers, shut out of the market for buying a house. An enormous number are living in apartments instead. This explains both the multi-decade lows in the homeownership rate as well as the recent 30 year lows in the apartment vacancy rates, as a disproportionate number of adults are forced out of home ownership and into apartment dwelling.

But even with the recent increase in mortgage payments, in relative terms they are still lower than they were at the peak of the housing bubble, and a relative bargain compared with their historical multiple of rental payments. In short, if one can get past the down payment, home ownership still looks like the better choice.

Along with the demographic tailwind, the *relative* inexpensiveness of monthly mortgage payments vs. rental payments goes a long way towards explaining why single family home construction has continued to increase in the face of higher mortgage rates.

That being said, with increasing financial stress showing up across the board in the costs of both buying and renting, we can only expect to see even more involuntary extended family households and involuntary unrelated housemates. Further, *if* interest rates and housing costs increase much further — most importantly, if home builders continue to focus on only the most expensive segment of the market — at some point they will overwhelm the increased numbers of home-buying age Millennials who have been buoying up the market. Sales will turn down, followed by home values, leading to another deflationary bust.

[Special thanks to Mike Kimel for preparing the customized comparative graphs used in this article.]

Comments (8)

Sound like what Trump was doing. Assets appreciate so you borrow more money to pay debt until the assets do not appreciate and you declare bankruptcy.

Daniel Becker

May 3, 2018 5:18 pm

And we have the record student loan indebtedness. I think this will be a factor as to how quickly if at all a person can get up the funds for the home buying deposit.

Being that we are doing nothing to change the way one pays for college, I think in time it will be a factor toward fewer buying homes, as it seems we are definitely at time going forward that college ed is needed to get to an income that would possibly allow savings for a deposit.

Though I have shown here some years ago that we have raised the cost of being 1950’s/60’s middle class to where 2 people working with bachelor’s starting pay is below that level.

run75441

May 3, 2018 6:08 pm

Daniel:

Most of the people I talk to on student loan debt, do not give a damn about them and believe they should have known better. It is the old I did it, you can also. Middle Class is certainly not Median Income. It has moved upwards from the Median.

sammy

May 3, 2018 7:08 pm

There must be a supply demand imbalance. They are building houses and apartments like crazy, I mean the returns are obviously there. Is the population growing faster than that? For all these years? Maybe just on the coasts?

EMichael

May 4, 2018 9:32 am

I’m a little confused here.

“Record down payments are keeping an increasing number of prospective buyers, especially first time buyers, shut out of the market for buying a house.”

Where does this come from? Has FHA suddenly increased their down payment requirements? With decent credit is is 3.5%, and if the loan officer knows anything at all, most of the closing costs can be rolled into the loan simply by using the seller’s 6% assistance levels. Personally, I think the reduction of that level from 10% was a big mistake and does hurt buyer’s, I do not get this “record down payment” thing.

One other thing, looking at interest rates during the bubble does not make a lot of sense considering the amount of arms during that period unless that is taken into account.

EMichael

May 4, 2018 10:58 am

BTW, I would suggest a fold. The length of the post makes it a pain to post.

One other thing about first time buyers. I doubt there are many states that do not offer assistance to first time buyers. Even AZ has:

“The Arizona Home Plus home loan program is very popular because the funds have been consistently available over the past few years. As such, many people in Arizona have been able to achieve the pride, stability, freedom and wealth that accompanies home ownership. The assistance program is structured as a three-year, no interest, no payment, soft second mortgage, forgiven monthly at a rate of 1/36 over the term of the lien. Once again, the lien is completely forgiven after you stay in the home for three years without refinancing. This type of lien is sometimes referred to as a silent second because you do not have to pay interest or make payments. Money from the Home Plus assistance is combined with government-sponsored mortgage programs and can be used for down payment and/or closing costs equal to as much as 5% of the mortgage loan.”

I see no such thing as high down payments needed to buy a home, particularly in the case of first time buyers.

Bern

May 5, 2018 6:33 am

Is it possible to account for the extra, sometimes ongoing, sometimes unanticipated, costs of home ownership? I’m thinking of property taxes obviously, but also maintenance, insurance, and those inevitable but often underfunded layouts for big appliances, new roof, burst pipes…

Renters do not pay for those in anything approaching coverage of total cost…

run75441

May 5, 2018 7:54 am

Bern:

Welcome to Angry Bear. First time commenters go to moderation to weed out spammers and advertising.

To your point, rent is a an approximation of cost over time as qualified by the amount of competition in the area in which the home or apartment is located.